Industrial Policy with Network Externalities: Race to the Bottom vs. Win-Win Outcome

Nigar Hashimzade and Haoran Sun

No 12592, CESifo Working Paper Series from CESifo

Abstract: Industrial policy has returned to the centre of economic governance, particularly in the high-tech sectors where positive network externalities in demand make market dominance self-reinforcing. This paper studies the welfare effects of an industrial policy targeting a sector with network externalities in a two-country model with strategic trade and R&D investment. We show how the welfare consequences of this policy are determined by the interaction between the strength of the externality, the type of R&D, and the degree of product differentiation between the home and the imported goods. When externalities are weak or the goods are close substitutes, the business-stealing effect produces a race to the bottom that dissipates more surplus than it creates. Under sufficiently strong externalities and weak substitutability or complementarity of the goods, industrial policy competition can make both countries simultaneously better off compared to the laissez-faire outcome because of the mutual business-enhancement effect. The case is stronger for the product innovation than for the process innovation, as the former directly affects the demand and triggers a stronger network effect than the latter which operates indirectly through the supply. Thus, network externalities create an opportunity for win-win industrial policies, but its realisation depends on the market structure and the nature of innovation.

Keywords: industrial policy; network externalities; R&D subsidies; strategic trade; Cournot competition (search for similar items in EconPapers)
JEL-codes: F13 H25 L13 O38 (search for similar items in EconPapers)
Date: 2026
New Economics Papers: this item is included in nep-com, nep-gth, nep-ind, nep-mic and nep-tid
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.ifo.de/DocDL/cesifo1_wp12592.pdf (application/pdf)

Related works:
Working Paper: Industrial Policy with Network Externalities: Race to the Bottom vs. Win-Win Outcome (2026)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_12592

Access Statistics for this paper

More papers in CESifo Working Paper Series from CESifo Contact information at EDIRC.
Bibliographic data for series maintained by Klaus Wohlrabe ().